Based on these facts, we believe you may offer a balloon loan that could pass under the ability-to-repay (ATR) analysis. However, as your financial institution is not a small creditor under the mortgage servicing rules, you would not be able to offer a balloon loan that would qualify as a qualified mortgage (QM). We also believe you may offer an adjustable-rate loan under the new mortgage servicing rules.
Balloon Loans and the Ability-to-Repay Rule
You may be able to make a balloon loan under the ATR analysis. However, for balloon loans with terms of five years or less, you will have to verify that your customer can make each loan payment, including the final balloon payment. For some customers, this may be possible, but we anticipate that this requirement would limit the pool of customers eligible to take out balloon loans with terms of five years or less.
The ATR rules require you to consider eight different factors in order to complete your “ability to repay” analysis. 12 CFR 1026.43(c)(1). Of those factors, the main hurdle for a balloon loan is the requirement to underwrite the consumer’s periodic payments. To satisfy that requirement, you would have to demonstrate that the consumer has the ability to pay the full balloon payment at the loan’s consummation.
However, if a balloon loan is not a higher-priced loan, you are required to consider only the “maximum payment scheduled during the first five years” of the loan. 12 CFR 1026.43(c)(5)(ii)(A)(1). In other words, you will not have to consider a balloon payment in making an ability-to-repay determination if the loan term is longer than five years and is not a higher-priced loan. But if the loan term is five years or shorter, you will have to consider the balloon payment in making an ability-to-repay determination (regardless of whether the loan is higher-priced or not). For examples of determining the ability to repay for balloon loan payments, see Official Interpretations, 12 CFR 1026.43, Paragraph 43(c)(5)(ii)(A), Comment 4.
When making a determination of a consumer’s ability to repay a balloon payment, the rules permit you to consider all sources of the consumer’s income and assets, including property other than the real property that secures the loan. 12 CFR 1026.43(c)(2)(i). The Staff Commentary includes several examples of other types of income and property that can be considered, such as “rental income, royalty payments . . . amounts vested in a retirement account, stocks, bonds, certificates of deposit, and amounts available to the consumer from a trust fund.” Official Interpretations, 12 CFR 1026.43, Paragraph 43(c)(2)(i), Comment 1.
Balloon Loans as a Qualified Mortgage
Generally, a QM cannot have a balloon payment feature. 12 CFR 1026.43(e)(2)(i)(C). However, there is an exemption to the general prohibition of balloon loans for balloon loans that are originated by small creditors that serve rural and underserved areas, as well as a temporary exemption for balloon loans originated by any small creditor. 12 CFR 1026.43(f). However, you have said your financial institution does not qualify as a small creditor, so we do not believe you may make a balloon that is a QM.
Adjustable-Rate Mortgages and the Ability-to-Repay Rules
We believe you may offer an adjustable rate mortgage (ARM) as either a QM or under the ATR analysis, provided that the loan meets the other requirements of the rules. Both the QM and ATR provisions specifically mention how to account for the consumer’s payments on an ARM.
With respect to a QM, one of the requirements of a loan in order for it to qualify as a QM is that there are regular periodic payments that are “substantially equal,” but the rule makes an exception “for the effect that any interest rate change after consummation has on the payment in the case” of an ARM. 12 CFR 1026.43(e)(2)(i). Similarly, like one part of the eight different factors in the ATR analysis, creditors are required to consider the consumer’s monthly payment on the loan, which must be made using the fully indexed rate or any introductory interest rate (whichever is greater) and the monthly, fully amortizing payments that are substantially equal. 12 CFR 1026.43(c)(2)(iii)12 CFR 1026.43(c)(5)(i). The Official Commentary makes clear that the monthly payment calculation method applies to ARMs and illustrates how to calculate the payment calculation for an ARM. Official Interpretations,12 CFR 1026.43 Paragraph 43(c)(5)(i),Comments 1 and 2. For an example of how to determine the repayment ability for a 30-year ARM with a discount of five years, see Official Interpretations,12 CFR 1026.43 Paragraph 43(c)(5)(i), Comment 5.
There are special disclosure requirements for ARMs. For more information, see 12 CFR 1026.19 (for example, creditors are required to provide the Consumer Handbook on Adjustable-Rate Mortgages — see 12 CFR 1026.19(b)(1)).